Chapter 11 The Basics of Capital Budgeting 349the IRR, the MIRR assumes that cash " ows are reinvested at the cost of capital
(or some other explicit rate). Since reinvestment at the IRR is generally not
correct, the MIRR is generally a better indicator of a project’s true pro! tability.
Second, the MIRR eliminates the multiple IRR problem—there can never be more
than one MIRR, and it can be compared with the cost of capital when deciding to
accept or reject projects.
Our conclusion is that the MIRR is better than the regular IRR; however, this
question remains: Is MIRR as good as the NPV? Here are our conclusions:
- For independent projects, the NPV, IRR, and MIRR always reach the same
accept/reject conclusion; so the three criteria are equally good when evaluat-
ing independent projects. - However, if projects are mutually exclusive and they differ in size, con" icts can
arise. In such cases, the NPV is best because it selects the project that maxi-
mizes value.^16 - Our overall conclusions are that (1) the MIRR is superior to the regular IRR as
an indicator of a project’s “true” rate of return but that (2) NPV is better than
IRR and MIRR when choosing among competing projects.
11-7 NPV PROFILES
Figure 11-5 presents the net present value pro! le for Project S. To make the pro! le,
we! nd the project’s NPV at a number of different discount rates and then plot
those values to create a graph. Note that at a zero cost of capital, the NPV is simply
the net total of the undiscounted cash " ows, $1,300 " $1,000! $300. This value is
plotted as the vertical axis intercept. Also recall that the IRR is the discount rate
that causes the NPV to equal zero, so the discount rate at which the pro! le line
crosses the horizontal axis is the project’s IRR. When we connect the data points,
we have the NPV pro! le.^17
Net Present Value
Profile
A graph showing the
relationship between a
project’s NPV and the
firm’s cost of capital.Net Present Value
Profile
A graph showing the
relationship between a
project’s NPV and the
firm’s cost of capital.(^16) See Brigham and Daves, Intermediate Financial Management, 9th ed. (Mason, OH: South-Western, 2007),
pp. 412–413.
(^17) Notice that the NPV pro! le is curved—it is not a straight line. NPV approaches CF 0 , which is the "$1,000
project cost, as the discount rate increases toward in! nity. The reason is that at an in! nitely high cost of capital, all
the PVs of the in$ ows would be zero; so NPV at r! ∞ must be CF 0. We should also note that under certain
conditions, the NPV pro! les can cross the horizontal axis several times or never cross it. This point was discussed
in Section 11-4.
SEL
F^ TEST What’s the primary di! erence between the MIRR and the regular IRR?
(reinvestment rate)
Which provides a better estimate of a project’s “true” rate of return, the
MIRR or the regular IRR? Explain.
Projects A and B have the following cash # ows:
0 1 2
A – $1,150 $ 100
B – $ 100 $1,300
Their cost of capital is 10%. What are the projects’ IRRs, MIRRs, and NPVs?
Which project would each method select? (IRRA! 23.1%, IRRB! 19.1%;
MIRRA! 16.8%, MIRRB !18.7%; NPVA! $128.10, NPVB! $165.29)